Glossary

Defined benefit & defined contribution pensions

In a defined benefit pension, you are guaranteed an income in retirement, calculated as a percentage of your final or average earnings.

There are two types of pension plan defined contribution and defined benefit. The former is more common in the private sector because it allows an employer to make a fixed contribution to an employee's pension pot, usually a percentage of their salary. When the employee retires, that pot is usually turned into an annuity (an income stream), the value of which is determined by the market.

With a defined benefit plan, on the other hand, an employer bears much more risk and also cost. That's because the employee is guaranteed an income in retirement, calculated as a percentage of their final or average earnings. The employee still makes a contribution from their salary but this does not directly affect the size of their final pension. Due to people living longer and poor recent stockmarket performance, this type of scheme is being phased out by companies. The other main provider, the government, is also looking at ways to reduce the cost to the taxpayer.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

See Tim Bennett's video tutorial: A beginner's guide to pensions.

Advertisement

Most Popular

Visit/economy/600632/money-minute-friday-17-january-uk-weakness-likely-to-continue
Economy

Money Minute Friday 17 January: UK weakness likely to continue

Today's Money Minute previews UK retail sales figures the UK, inflation data from Europe and industrial production from the US.
17 Jan 2020
Visit/520525/currency-corner-how-high-can-the-pound-go-against-the-euro-in-2020
Currencies

Currency Corner: how high can the pound go against the euro in 2020?

In the month in which we should finally leave the European Union, Dominic Frisby takes a look at the pound vs the euro and asks just how high sterling…
13 Jan 2020
Visit/investments/property/house-prices/600638/uk-house-prices-may-be-heading-for-a-boris-bounce
House prices

UK house prices may be heading for a Boris bounce

The latest survey of estate agents and surveyors from the Royal Institution of Chartered Surveyors is "unambiguously positive" – suggesting house pric…
16 Jan 2020
Visit/investments/stocks-and-shares/share-tips/600636/class-acts-going-cheap-buy-into-europes-best
Share tips

Class acts going cheap: buy into Europe’s best bargains

Value investing appears to be making a comeback, while shares on this side of the Atlantic are more appealing on metrics such as price/earnings ratios…
16 Jan 2020